Amendment to IAS 39 for eligible hedged items

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30 Jul 2008

On 30 July 2008, the IASB published amendments to IAS 39 'Financial Instruments: Recognition and Measurement' to clarify two hedge accounting issues.

The two issues are:

  • Inflation in a financial hedged item
  • A one-sided risk in a hedged item

The amendments are based on the September 2007 exposure draft Exposures Qualifying for Hedge Accounting, but focus more narrowly only on the two foregoing areas.

The amendment does not address either (a) what can be designated as a hedged portion under IAS 39 or (b) the European carve-out option used by a few European companies. These issues will be addressed separately.

Inflation in a financial hedged item Inflation may only be hedged if changes in inflation are a contractually specified portion of cash flows of a recognised financial instrument. Therefore, where an entity acquires or issues inflation-linked debt, it has a cash flow exposure to changes in future inflation to which cash-flow hedge accounting may be applied. However, the amendment clarifies that an entity may not designate an inflation component of issued or acquired fixed-rate debt in a fair value hedge because such a component is not separately identifiable and reliably measurable. The amendments also clarify that a risk-free or benchmark interest rate portion of the fair value of a fixed-rate financial instrument will normally be separately identifiable and reliably measurable and, therefore, may be hedged.

A one-sided risk in a hedged item IAS 39 permits an entity to designate purchased options as a hedging instrument in a hedge of a financial or non-financial item. The entity may designate an option as a hedge of changes in the cash flows or fair value of a hedged item above or below a specified price or other variable (that is, a one-sided risk). The amendments make clear that the intrinsic value, not the time value, of an option reflects a one-sided risk and, therefore, an option designated in its entirety cannot be perfectly effective. The time value of a purchased option is not a component of the forecast transaction that impacts profit or loss. Therefore, if an entity designates an option in its entirety as a hedge of a one-sided risk arising from a forecast transaction, hedge ineffectiveness will arise. Alternatively, an entity may choose to exclude time value as permitted by IAS 39 to improve hedge effectiveness.

The amendments to IAS 39 are effective for annual periods beginning on or after 1 July 2009, with earlier application permitted, and must be applied retrospectively. Therefore, if an entity has a hedge accounting relationship that is no longer considered qualifying under the amended IAS 39, the entity must restate its comparative prior period(s).

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